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Part VIII: “Ex Disastrium, Scientia”

(excerpted from The Pipeline: A Picture of Homebuilding Production, originally posted on Escape from Averageness in July 2010, updated and reposted here)

“Breakeven in our worst case scenario occurs at around 190 closings — about $46 million in Revenue. Which happens because we are trying to absorb the same amount of overhead with smaller Gross Margins. It requires more closings, which can become a vicious cycle, with a lot of margin pressure.

“Anyway, in the worst case scenario, the point at which we fully absorb our overhead occurs at a rate of about 16 closings per month; in spite of the fact that we have the production capacity to start and close 25 houses a month.”

The CFO filled in the missing data for the last two columns.

2008 BASE BUDGET

CLOSINGS = 200

REVENUE = $50,000,000

AVG. SP = $250,000

GROSS MARGIN = 22%

BREAKEVEN = 155 UNITS

BREAKEVEN REVENUE = $39,000,000

2008 TARGET BUDGET

CLOSINGS = 250

REVENUE = $60,000,000

AVG. SP = $240,000

GROSS MARGIN = 21%

BREAKEVEN = 170 UNITS

BREAKEVEN REVENUE = $40,500,000

2008 WORST-CASE

CLOSINGS = 140-150

REVENUE = $34,500,000

AVG. SP = $240,000

GROSS MARGIN = 18-19%

BREAKEVEN = 190

BREAKEVEN REVENUE = $46,000,000

2008 FULL CAPACITY UTILIZATION

CLOSINGS = 300

REVENUE = $69,000,000

AVG. SP = $230,000

GROSS MARGIN = 15%

BREAKEVEN = 246

BREAKEVEN REVENUE = $56,600,000

“Obviously, at only 140 to 150 closings – 12 closings per month – and $34.5 million in Revenue, we would be below the breakeven point in both closings and Revenue, which means we would be losing money.

“But, if we can somehow find a way to more fully-utilize our production capacity – which we will pay to have anyway, unless we cut our overhead – and somehow find a way to close more homes, albeit at considerably lower margins, we would breakeven at 246 closings and $56.6 million in Revenue. That occurs at 20-21 closings a month, a rate that is well-below the 25 closings-per-month we have the capacity to produce.

“And, while we are talking about breakeven rates, I hope it reinforces the importance of even-flow production”, said the intrepid, results-based consulting, looking at the VP of Construction and VP of Sales. “We cannot be all over the map each month with sales, starts, and closings, and with WIP.”

“Is there any kind of housing market in which demand does not respond to lower sales prices?”, asked a sales representative. “What happens if we reduce the sales price – give more concessions, endure lower margins – and there are insufficient sales? Is there a limit to how far we can drop prices? In other words, what happens if we build it, we drop the ticket prices, and they still do not come?”

“There is always that possibility”, said the VP of Sales. “But – we still have to price to the market; that is not in our control. To the extent that we extract value, better margins are the outcome, and, in that regard, we do have some control. On the other hand, from what I am hearing, the gains from higher productivity are permanent, and the speed/velocity that enables those gains is something we can always control.”

“To answer your question, if the situation gets bad enough, higher productivity becomes moot”, said the intrepid, results-based consultant. “RB Builders would have excess, probably unusable capacity. In that case, higher productivity might not seem as urgent, or as attractive.

“If we cannot make some combination of higher margin and higher velocity work for us, we might have to take RB Builders out-of-gear, and glide to some sort of safe landing; a controlled crash would be a better description. Sort of like Apollo 13; forget the lunar landing, just try to get Odyssey and the crew home.”

“Perhaps”, said the CEO. “But, I am determined that we come out of this situation with a level of sustainable competitive separation. I refuse to accept the sacrifice of having endured this much pain without having something to show for it. Higher productivity might not seem as urgent, right now, but it will someday. I want RB Builders to emerge a much faster and more agile homebuilding company.

“Forget ‘industry best practices’. We need to do better than that, because we would be foolish to believe that our competition will forever come from who it comes from now. Someday, the homebuilding industry is going to change, and that change will as likely come from without, as from within.”

(The Pipeline: A Picture of Homebuilding Production is available on the publisher website (virtualbookworm.com), and the author website (thepipelinebook.com), as well as amazon.com, barnesandnoble.com, and booksamillion.com)

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